Why Does the Charging Order Law Exist?

Understanding General Partnership and Charging Order

After teaching people about the family limited partnership and the power of the charging order, we often hear the comment, “This sounds too good to be true.” So why does the charging order law exist?

When two or more people desire to work together for a business purpose, they often form what is called a general partnership. This can be a written or oral agreement between the partners or can be an implied general partnership based on the working relationship. The general partnership is a common form of business because it is the default partnership arrangement and requires no state filings or paperwork.

A general partnership is a very dangerous way to conduct business because of the unlimited liability of the partners. For example, if two or more doctors opened a practice together as general partners, each doctor would be personally liable for his own actions and would also be liable for the negligence or malpractice of the other doctors in the partnership. If one doctor was sued and the plaintiff won a $10 million judgment against him or her, the plaintiff creditor could take assets from all of the doctors in the general partnership to satisfy the judgment.

Also, in a general partnership, any one partner can enter into contracts binding on the general partnership and the other partners are personally liable for the terms of the contract, even if they had no knowledge of the contract and did not authorize the action. For example, Dr. William is one of two doctors in a medical general partnership, and his partner took a million-dollar loan on behalf of the general partnership without Dr. William’s knowledge and without his approval. When Dr. William’s partner was unable to repay the loan, Dr. William was 100% responsible to repay the million-dollar loan.

Under the terms of a general partnership, the assets of the partnership can also be taken to satisfy the non-partnership debts of one of the partners. For example, if one partner was sued for an accident at his home, the judgment creditor could obtain a Writ of Execution to seize the assets of the general partnership to satisfy the judgment, regardless of the fact that the partnership had no involvement or liability in the case.

The results of unlimited liability of all the partners in a general partnership has resulted in businesses being destroyed and significant economic injustice to non-debt partners as their portion of assets were seized to satisfy one partner’s debt. The unlimited liability of the partners on behalf of the general partnership and other partners was detrimental to the formation of partnerships, so every state enacted legislation allowing the formation of a type of partnership known as a limited partnership.

Limited Partnership

Under the terms of a limited partnership, a creditor with a judgment against a partner, but not against the partnership, cannot seize the partnership assets as he could under the terms of a general partnership. Thus, a limited partnership limits the liability of the partners. Instead of being allowed to seize assets, the law only allows the creditor to obtain a charging order, which affects only the actual distributions made from the partnership to the debtor partner. The business of the partnership is allowed to continue unimpeded, and the assets and distribution of the non-debtor partner(s) is not affected.

The protection of assets in a family limited partnership is not the result of a loophole or a twisting of the law. The laws preventing a creditor from taking assets from a limited partnership are well established and have decades of precedence with the courts upholding these asset-protecting provisions. Having an available alternative to general partnerships is desirable and necessary and was created for the very purpose of limited liability, so it is very unlikely that laws would ever be changed to eliminate the asset-protection provisions of the charging order.

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